348 MAB 90(9)SEPTEMBER 2016
SPECIAL ISSUE
A discussion of “Auditor-client
co-production of the audit and the
effect on production efficiency”
Sytse Duiverman and Christine Nolder
SUMMARY This article provides a reflection on the paper and presentation during the
FAR Conference of 9 and 10 May 2016 of “Auditor-client co-production of the audit and the effect on production efficiency” by Gaeremynck, Willekens, and Knechel (GWK). The authors examine the effect of auditor-client co-production on the efficiency of an audit, a topic relevant to the whole audit-client financial reporting and assurance supply chain. Using a sample of working papers from a Belgium Big 4 firm, the au-thors explore the controllable (i.e., managerial) and non-controllable (i.e., environmen-tal) factors that contribute to variations in audit efficiency within the auditor-client co-production of financial reporting quality. The results suggest that partner tenure positively contributes to the efficiency of the audit engagement, but the audit work prepared by the client, interim-work by the auditor, and the final audit work performed during off-peak season negatively affect audit efficiency. While this may be surprising from an efficiency standpoint, it may be that such measures add to the audit effective-ness to an extent that outweighs any efficiency loss. Audit quality or audit production, after all, is a matter of efficiency and effectiveness. GWK offer a number of important insights for practitioners interested in the delicate balance of managing efficiency and effectiveness. In the paragraphs that follow, we aim to both summarize the GWK re-search and highlight the importance of the findings to practice.
PRACTICAL RELEVANCE GWK lay the foundation for future advancements in audit
efficiency research in a number of ways. Academics and practitioners can work to-gether to refine the audit efficiency model to include additional variables (e.g., num-ber of subjective accounts, numnum-ber of critical accounting policies, senior/manager tenure) that significantly affect audit efficiency. When inefficient audits are identified both within a firm office (e.g., Boston office) and across offices around the globe, the model can inform managing partners at both the local and global level about poten-tial root causes of engagement inefficiencies. Moreover, academics can work with practitioners to develop audit efficiency models on an account level basis to identify when too much time is being spent on low risk areas. Future research opportunities include extending the model to identify audits that are perhaps, too efficient. For ex-ample, overly efficient audits may represent a red flag that a particular audit team may be cutting corners and not adhering to firm methodology.
1
Introduction and background
What do we know about the production process of the audit? Production is the process of converting a set of inputs into a set of outputs that have economic value (Shepherd, 1970). Production efficiency is generally defined in terms of minimizing the inputs to a produc-tion process for a given level of output (Fried et al., 2002). Up until now, only a few studies have examined audit production efficiency, in part, because of a lack of accessible data from firms (Causholli, De Martinis, Hay & Knechel, 2010). Despite this limitation, a scarce number of studies on audit production have provided valuable insights regarding the efficiency of the audit process.
Dopuch et al. (2003) use Stochastic Frontier Analysis (SFA)1 and Data Envelopment Analysis (DEA) to
MAB 90(9)SEPTEMBER 2016 349 spent on assurance increasing activities (such as audit
planning, internal control evaluation and substantive testing) are used as an output measure since these ac-tivities would presumably lead to a higher level of assur-ance. Knechel et al. (2009) find that audits are more ef-ficient for (1) larger clients, (2) clients with a December year-end and (3) clients who are more automated. Au-dits are less efficient when auditors (1) rely on internal controls, (2) provide non-audit services and (3) when cli-ents have subsidiaries. However, after the publication of Knechel et al. (2009) it was still unclear to what extent firms could control variations in audit efficiency.
2
Summary of Gaeremynck, Willekens and
Kne-chel (2016)
In practice, it is generally assumed that more intensive client co-operation leads to more efficient audits. GWK seek to assess how the joint decisions (e.g., reliance on internal audit or the timing of the audit work) made by the auditor and client influence the efficiency of au-dit engagements. They begin by suggesting that differ-ent audit approaches yield differdiffer-ent levels of assurance even though the final output for each audit is unitary (i.e., audit opinion). That is, the audit approach is based on the professional judgement of the auditor and is reflected in the risk assessment, the level of ma-teriality, and the extensiveness of the planned audit procedures.
Unlike previous studies, GWK measure the variation in assurance by using the engagement’s final material-ity level. They explain that because lower materialmaterial-ity requires more extensive audit work, one can assume that different levels of materiality lead to relatively dif-ferent levels of assurance (assuming all else equal). Therefore, GWK use materiality as their output meas-ure (i.e., dependent variable) for measuring the efficien-cy of the audit process.
In general, the audit process is a complex service which is highly dependent on the unique characteristics of both the client and the auditor. Inefficiencies in the audit process may stem from auditors’ choices in the production process and client specific characteristics. GWK develop a model to disentangle the controllable factors from the non-controllable client specific fac-tors. This distinction is important to elucidate poten-tial strategies for improving the efficiency of audits. The study was conducted on 158 diverse audit engage-ments for the year ends 2006 or 2007. GWK’s data in-cludes publically available client data and data from a Belgium Big 4 audit firm (i.e., audit team information, client information, hours performed per staff level, deadline information, engagement specific informa-tion and deliverables).
To disentangle managerial from non-controllable ef-ficiency, GWK’s model includes a three-stage DEA
ana-lysis to determine the level of managerial and non-con-trollable efficiency:
Stage 1: DEA-analysis with fundamental inputs (labor) and outputs (materiality) to determine preliminary ef-ficiency.
Stage 2: Apply DEA to inefficiencies (slack) of stage 1 and environmental factors to isolate environmental or non-controllable inefficiencies.
Stage 3: Apply DEA to fundamental inputs and out-puts after adjusting for environmental factors isolat-ed in step 2 to assess managerial or controllable inef-ficiencies.
The estimated managerial and non-controllable inef-ficiencies were thereafter incorporated in a regression analysis to determine which aspects of the auditor-cli-ent co-production are associated with more or less managerial controllable inefficiency. Variables in the regression include controllable characteristics of an audit such as composition of the audit team, partner tenure, manager tenure, substantive testing before year end, interim audit, audit report lag, internal audit ben-efit and auditor’s use of work prepared by the client.2
GWK found that partner tenure positively contributes to audit efficiency, but that preparation of the audit work done by the client, interim work and final audit work done during off-peak season negatively affects efficiency. The evidence for a negative relationship be-tween interim-work and preparations made by the cli-ent are surprising because they contradict the assump-tion that these factors contribute to audit efficiency. Furthermore, contrary to expectations, the results sug-gest that no efficiencies are realized by relying on the client’s internal audit department, providing non-au-dit services to the client, and having a higher qualified audit team. The authors do not hypothesize about the reasons for the unexpected findings. However, with re-spect to the internal audit department, it is possible that client delays in deliverables disrupt the schedul-ing of the field work and thus, affect the efficiency of the engagement.
3
Recommendations, implications, and
consider-ations for science and practice
3.1 Audience
350 MAB 90(9)SEPTEMBER 2016
by academics. Moreover, the authors appeal to aca-demics by introducing a new approach to measuring audit efficiency using their three-stage process. Besides academics, it stands to reason that practition-ers have the most to gain from scientific advances in audit efficiency (and effectiveness) research. That is, improving our understanding of how firms can meas-ure, monitor, and thus, manage audit efficiency with-in and across firms are of great importance to practi-tioners. In the next section, we further elaborate on the significant contribution of audit efficiency research to practitioners.
3.2 Importance
The importance of the research is currently described in terms of demonstrating how to separate out the controllable (i.e., managerial) factors from the uncon-trollable (i.e., environmental) factors so that firms can focus on what is in their control. Based on the fram-ing and the tone of the writfram-ing, readers may infer that the uncontrollable factors are not informative and thus, can be set aside to focus on what is controllable. However, isolating the relationship between the un-controllable factors and audit efficiency is of signific-ant value to firms. That is, knowing how to measure the uncontrollable factors and their relationship with the number and mix of audit hours within and across offices has the potential to significantly improve the firm’s operations. Currently, firms have systematic models (or at the very least, benchmarks) for how many hours and what mix of rank hours are necessary based on client factors such as size, risks, complexity, con-trols, etc. Firms can benefit from audit efficiency re-search by measuring the actual hours and mix for each audit and comparing the efficiency scores of each to determine the extent to which audits appear to be im-properly staffed when controlling for managerial fac-tors. As such, GWK’s research disentangling the con-trollable and unconcon-trollable factors has the potential of benefiting practice to a much greater extent than presently described.
3.3 Contribution/implications
The contribution/implications of this research extends beyond the newly introduced statistical approach sug-gested by the authors. The research offers a means for examining the relationship between audit efficiency and audit quality. To illustrate, imagine a firm that cal-culates the audit efficiency scores for all audits inspect-ed by regulators each year. Over time, the firm can identify a relationship between audit efficiency and au-dit quality. The firm can then calculate the auau-dit effi-ciency scores for all audits and preemptively identify the audits that have a greater likelihood of containing audit deficiencies. Further investigation may reveal these audits may be indicative of cultural differences across offices or perhaps training issues in one or more locations. As such, the identified audits may warrant remediation such as greater supervision or an alterna-tive mix of staffing.
4
Conclusion
In short, GWK add to our understanding of the driv-ers and impediments of audit efficiency. Moreover, their model provides a means for isolating uncontrol-lable client factors, which may lead to strategies for monitoring and managing engagement compliance with firm methodology. Such advancements may lead to measured improvements in the standardization of audit quality within global network firms. In conclu-sion, GWK exemplify the advantages of a close coop-eration between researchers and practitioners and how such cooperation can lead to new insights that will move relevant audit research forward.
SPECIAL ISSUE
Notes
Stochastic Frontier Analysis is a method of economic modeling. Further explanation of this method is beyond the scope of this paper.
Non-controllable characteristics of an audit
Drs. S.J. Duiverman RA is PhD at Tilburg University. Dr. C. Nolder CPA is an Assistant Professor at Suffolk Uni-versity, Boston.
MAB 90(9)SEPTEMBER 2016 351 References
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